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Retail: Cost vigilance throughout

Jun 26, 2009

In our previous articles we highlighted the issues faced by the retailers and the operational issues that impacts their ability to sustain and/or improve profitability. In this article we will take a look at the parameters whereby a re-evaluation may cushion their margins and boost growth.

Cost checking: Costs should not only be monitored when margins start shrinking during a downturn. It should be an exercise practiced right from the beginning and on a continuous basis.

In the recent past, Pantaloon had come out with a slogan "Garv se bolo hum kanjoos hain" to rationalise cost cutting. The idea was to understand the need to contain costs and eliminate inefficiencies. The move ensured that internal overlapping of functions was avoided as human resources and information technology was integrated. With this campaign, the company aimed to save Rs 1.7 bn (US$ 36.5 m) over a one year period. Cost control measures were initiated only in 2008, in anticipation of the slowdown witnessed in FY09. Although the move worked in favour of the company, we believe it should be an ongoing activity.

How can retailers keep check on costs right from the beginning? For that, they need to identify the areas where costs need to be checked regularly such as pilferage, handling, theft, overlapping of functions, excess floor staff etc. and accordingly need to re-align functions and responsibilities. For instance: To lower cost, business risk etc., retailers can enter into arrangements with vendors in various business formats such as Consignment & Concessionaire/Conducting arrangement. How does it benefit? Costs related to merchandise received under consignment and concessionaire arrangements belong to the consignors / concessionaires such as inventory, staff etc. The cost of sales and sales value can only be recorded by the retailer in profit and loss account.

Optimize resources and improve labour productivity: One way to optimize resources is to centralize some of its operations like distribution, and back-office operations, as well as resize stores (store count as well as size of stores). Retailers are going slow on hiring back end staff or have linked compensation to performance in order to improve labour productivity.

Inventory management:For this, the retailer first needs to understand the local customer and accordingly stock products. The retailer should always maintain sufficient inventory to cater to the needs of the people. It should not be a case of excess or deficit. To ensure this, the retailer needs to conduct a proper market research towards understanding the needs and frequency of the purchases of the residents. Market research will help retailer to get a judgment regarding purchase patterns and accordingly help him to stock offerings but real understanding will take place as store becomes operational. According to the response they receive, they need to streamline their inventory, as bargain hunting may result in overstocking and this will increase their inventory cost if found unable to sell it.

Nowadays, the term inventory management or inventory control is not just restricted to purchases and sales but is also applicable to handling too. Here, store operations play a significant role as it involves a check on shrinkage. Shrinkage in the retail business is defined as the loss in inventory through a combination of shop lifting, pilferage, and errors in documentation. A well defined process for physical counting of inventory, digital surveillance, etc. can help reduce shrinkage ratio. In India shrinkage ratio is around 2.95 and highest in the world.

Renegotiate rentals: Rentals constitute a greater portion of total costs. The average cost of rentals as a percentage of sales has been around 10% in the past 4 to 5 years. The rentals were on the higher side in 2008. However, in recent times, mall rentals have fallen up to 50% compared to their peak in FY08. This has enthused retailers to kick start their expansion plans. At the same time, they should also look to renegotiate rentals and bring down their overall costs. An alternative is the retailers adopting a revenue sharing model. In a revenue sharing model, a certain percentage of the sales are paid to the mall owner or developer. This works out as a win-win model.

Re-evaluating store viability and expansion plans: Retailers need to analyze whether the store is a cash cow or a drag on the company's finances and accordingly take a call. There can be 4 situations.

    Low cost and high sales: Such a store is a profitable store. One should consider expansion of such stores, and invest time and money in such stores to further enhance volumes and profitability.

    Low cost and low sales: In this case, there is a scope for improvement as the costs are on a lower side. Cost factor is not the issue. One needs to boost sales. To achieve this, a retailer needs to increase footfalls by improving visibility of the store in the minds of the customer. Put more time and effort into understanding the issues concerning conversion (footfalls into cash memos), as lower footfalls may not be the only issue that needs to be tackled. To increase conversion ratio, train employees, ensure ambience and store display is good enough to attract customers, etc.

    High cost and high sale: In this case, volume sales are on a higher side. The store is able to find takers. What is required is cost rationalization. The cost of operation may be on a higher side owing to high rentals, high maintenance cost, which could be the result of wrong structure or design of the mall or retail outlet, needs to rationalize employee cost, etc. Check on costs may help improve profitability and viability of operations.

    High cost and low sales: Now, such a case is a clear indication of a drag on the overall business operations. A store which has high cost of operation and low sales needs reconsideration. Either the location is wrong or there is a mismatch in terms of offerings and target segment. Retailers should close such unviable ventures and shut the store. This is where market research plays importance, by identifying target segment and location.

On a concluding note:

Well planned and focused expansion plans will help the retailer minimize high cost issues or resolve the same. Retailers are currently testing markets and different formats. They had come out with different size of formats across categories. The retailers need to evaluate whether they understand the customers' requirements depending upon locality. The business model of value retailer and life style retailer is very different. Operations and working capital requirements are different. Again, the skills differ as per the category and the products served. The food business has a low shelf life and requires a regular supply of various products. It comes under 'value retailing', which is a low margin - high volume business. On the other hand an apparel retailer would be regulating a high margin - low volume business and would need to concentrate on parameters such as style and fashion, apart from quality factor.

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